Mortgage Debt Is NOT the Main Factor Holding Back U.S. Growth Back

Friday, 30 September 2011 05:15

The NYT had an article about the prospects of persistently slower growth in Europe and the U.S. as a result of the current downturn. It told readers that:

"Now, just as the United States economy is held back by households whose mortgages are still underwater and who won’t begin to spend again until they have run down their debts, Europe can’t begin to grow again until its countries learn to live within their means."

Actually, the United States economy is not being held back by a lack of consumer spending. The ratio of spending to income is still considerably higher than the pre-bubble average as reflected by the lower than normal saving rate. The problem is that the bubble had generated excessive consumption demand, which is not being replaced by any other source of demand.

Source: Bureau of Economic Analysis.

The piece also inaccurately asserts that:

"in Europe it was mainly governments that piled on the debt, facilitated by banks that lent them money by buying up sovereign bonds."

Actually, Ireland and Spain, two of the most troubled countries, ran budget surpluses in the years preceding the downturn. They ran into trouble because they both had large housing bubbles which burst and left their economies in crisis.

It would also have been useful if the chart showing debt to GDP ratios included Japan. The IMF shows Japan's debt to GDP ratio at the end of this year as being 229 percent. Excluding Greece, this is almost twice as large as any debt burden shown in the chart. Japan can currently pay just over 1.0 percent interest on its long-term debt. If Japan had been included, it would have suggested that the debt levels may not be as troubling as the piece implies.

It looks increasingly obvious to me that in order for households to save at "normal" levels and the nation to "normal" levels of unemployment, without piling on debt, we would have to drastically reduce the trade deficit: http://cr4re.com/charts/charts...y2011.jpg

Check out the extraordinary widening of the trade deficit in the late 90s on this chart and look at the big leg down in savings in the above chart at the point in time.

The marginal dollar of household spending goes disproportionately to imports anyhow so it wouldn't help us that much.

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Baker Caves In and Adopts Position of Austrian Economistswritten by izzatzo,
September 30, 2011 7:51

The problem is that the bubble had generated excessive consumption demand, which is not being replaced by any other source of demand.

Exactly. This is what the Austrian economists have been saying all along. The bubble represented excess demand above the true natural rate of full employment (NRFU) so the so called 'deep recession' is to be expected and necessary to cure the aberration of an asset bubble pumped up by interference with market forces.

This is what happens when one fools with mother nature and the natual forces of a balanced equilibrium allowed to seek its own level. Get over it and move on.

Stupid liberals.

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Interference with market forces?written by EMichael,
September 30, 2011 8:34

Pull the other one.

We, and Europe, did not regulate those and/or interfere with market forces enough, not too much.

Only an ideology driven and intentionally uninformed person can possibly think the financial crisis was caused by interference in the market. Well, maybe not "only", ther is always imbeciles in the world.

Sadly, Dean sold out to the Austrian "freshwater" cult some time ago. He has now joined up with Yosemite Sam Perry to bash Keynes for advocating increasing consumption, ironically on the same day that CR says PCE has been weak.

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...written by skeptonomist,
September 30, 2011 9:31

Well, people are not spending on houses, which means that construction remains depressed. Others (e.g. DeLong) have claimed that there was never really an excess supply of houses and may be a shortage now in terms of historical trends. (Housing starts did not take off in the bubble, they had just increased steadily from the early 90's). If that is true, mortgage debt is a major constraint, and clearing it up could provide a quick boost by reviving construction. Banks, with the aid of the Fed and Treasury, have blocked efforts to do this.

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...written by Kat,
September 30, 2011 12:02

@Paul, ..ummm perhaps it is better for the government to do the spending rather than households?

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No Kat, the Government Does Not Have the Ability to Increase Its Consumption Nowwritten by Paul,
September 30, 2011 12:15

In theory, the federal government, with the unlimited ability to incur debt, could increase spending to make up for the shortfall of consumer demand. That is what happpened during WWII and it ended the Great Depression.

But as Keynes said 75 years ago, governments usually don't massively increase spending except for wars or some other highly compelling reason. As we have witnessed for the past 2 years, government spending across all levels, has actually been reduced and constituted a drag on the recovery.

That leaves consumer spending as the only available means to increase demand and therefore jobs. Dean has proposed devaluing the dollar to increase exports and diminish imports, but politically that plan has no chance either, for obvious reasons.

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...written by Kat,
September 30, 2011 12:26

But as Keynes said 75 years ago, governments usually don't massively increase spending except for wars or some other highly compelling reason. As we have witnessed for the past 2 years, government spending across all levels, has actually been reduced and constituted a drag on the recovery.How does this strengthen your argument?

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...written by David S.,
September 30, 2011 12:30

Dean,

Your comment that "the bubble had generated excess consumption demand" is poorly phrased, and not, I think, precisely what you intended to convey.

The upside, if you will, of the "bubble" is that it created an increase in aggregate demand sufficient to employ millions of wokers and to allow the economy to operate at or close to full capacity and full employment, broadly defined.

When the "bubble" burst, such individuals and resources were left unemployed. There is no reason -- as I am sure you intended to make clear -- that the aggregate demand created by the poor foundation of the real estate "bubble" could not be replaced -- and must be replaced -- by aggregarte demand from elsewhere in the economy. Since it is not coming from Consumption, Investment (in sufficient amounts) or Net Exports, only Government Spending can fill the gap.

Anyway, I am pretty sure that it is what you meant.

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David's rightwritten by Peter K.,
September 30, 2011 1:02

I agree with David S. Is the only way to get to full employment via bubbles? What if we had competent, on-the-level regulators and the bubble had been prevented from blowing up?

The Onion had a healdine in 2008 saying investors are demanding another bubble in which to invest.

Well we need something. The conventional wisdom is that businesses aren't expanding and hiring because they have no consumers and no demand. Except Dean says consumer buying levels are up to where they were. As I understand it, business investment is up and exports are up, but residential construction and government purchases are down. There's also the Rogoff/Koo notion that there's a lack of demand because people are underwater on their mortgages and there's deleveraging in the economy. And then there's the trade deficit.

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Kat, if government spending is falling because of politicswritten by Paul,
September 30, 2011 1:16

Then what is left to increase demand except consumers? Since consumer demand is 70% of GDP, there is simply nothing else to provide the demand needed to create jobs and growth.

Dean's idea that we devalue to dollar and start a trade war is not only anti-Keynesian, it is doomed to fail, just as the Smoot-Hawley tariff failed during the Great Depression.

The real failure of economists for the past 3 years has been to ignore consumer demand as the main engine of economic growth in the U.S. Only Christine Romer has been the true Keynesian on what should be obvious by now.

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...written by Kat,
September 30, 2011 1:44

Paul, And I would say the real failure of economists of the past 30 years is to see consumer spending as the main engine of economic growth. So, we shall have to disagree. (sorry, "agree to disagree" is too trite)

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Excesswritten by PeakVT,
September 30, 2011 1:48

@David S. - Yes, the bubble put more people to work at the time, but it was only able to do so by building more housing, CRE, cars, and other things than a non-bubbly economy would have demanded. The down side is that at some point those same things will have to be built at a lower rate than a normal economy would demand, throwing lots of people out of work. Because a crash can devastate individuals lives, as well as lower long-term growth, I think it would have been better to have a slower growing economy, with somewhat higher unemployment, than a bubble and the subsequent crash.

It isn't an either-or question, though. Economies don't have to be organized the way the US economy was from 2001-2008, or is now.

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Kat, Past 30 Years? More Like the Past 66 Years of Consumer Demandwritten by Paul,
September 30, 2011 2:01

Driving the economy forward. In other words, the entire post-WWII era in the U.S. has been driven by consumption. In fact, the world economy as a whole has prospered largely on the demand created by U.S. consumers.

It has been a great ride and we could do it again, but the moralists who are anti-consumption are holding us back. As Keynes said 75 years ago, consumption is obviously the purpose of economics.

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non-bubbly?written by Peter K.,
September 30, 2011 2:13

PeakVT:

"Yes, the bubble put more people to work at the time, but it was only able to do so by building more housing, CRE, cars, and other things than a non-bubbly economy would have demanded."

Say that credit hadn't been malinvested in the bubble, but invested in something more productive? Say the financial sector had been taxed more? I wouldn't agree with Austrians and Ron Paul that the Fed held rates too low for too long. Some people were given credit who shouldn't have received it obviously.

@Peter K. - well, yes, if the economy had been run right, things would have turned out better. The problem with the Fed's approach was that rates were held low AND credit standards abandoned at the same time. Holding rates low made sense in response to the 2001 recession. But the ridiculous loans didn't, and the novel ways of securitizings those and other loans didn't.

Those weren't the only things that were wrong, though. Upward redistribution of income and significant underinvestment in public goods (roads, bridges, sewers, transit, etc.) were (and are) two more.

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Froth & Bubbles.written by Ralph Musgrave,
September 30, 2011 2:55

Excess says “the bubble put more people to work at the time, but it was only able to do so by building more housing, CRE, cars, and other things than a non-bubbly economy would have demanded”. Don’t agree.

In a bubbly economy people do not go out to work, earn money and consume MORE THAN THEY WANT TO. I.e. in the absence of a bubble, government / Fed would ideally have kept demand at the full employment level: pretty much the “bubble” level that actually existed prior to the crunch.

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Izzatso Caves and Says The True Natural Rate of written by BigBozat,
September 30, 2011 4:54

Izzatso said: "The bubble represented excess demand above the true natural rate of full employment (NRFU) so the so called 'deep recession' is to be expected and necessary to cure the aberration of an asset bubble pumped up by interference with market forces."

Hmm... let's see... if that were true, then unemployment during the formation & peak of the bubble era must have been abnormally low, n'est-ce pas?

Yet, the average seasonally-adjusted unemployment rate from, let's say, Jan-2001 thru May-2006 {when home prices reached their peak} was 5.4% (and the median = 5.5%, both as per per BLS monthly data), and never got below 4.2% at any point during the period.

Are you saying the True Natural Rate of Full Employment calls for an unemployment rate [substantially] higher than 5.5%, as it must if it is to cause an asset bubble? Curiouser and curiouser... I've not heard any credible macroeconomist suggest such, and in fact the numbers typically suggested are much lower.

David S is right. The problem was housing wealth driven driven consumption, not consumption per se.

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Keynes on Consumptionwritten by Paul,
October 01, 2011 8:08

Consumption — to repeat the obvious — is the sole end and object of all economic activity.

The General Theory of Employment, Interest and Money, p. 104.

If it is impracticable materially to increase investment, obviously there is no means of securing a higher level of employment except by increasing consumption. . . . I should support at the same time all sorts of policies for increasing the propensity to consume. For it is unlikely that full employment can be maintained, whatever we may do about investment, with the existing propensity to consume.Id., p. 325

Keynes DID NOT distinguish between consumption driven by income or wealth of any kind. Dean is making a false distinction in Keynesian terms.

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The Times Focuses on the Wrong Spenderswritten by LSTB,
October 01, 2011 9:51

"Now, just as the United States economy is held back by households whose mortgages are still underwater and who won’t begin to spend again until they have run down their debts."

The Times thinks that a large swath of consumer spending comes from a broad middle class that has the income to spend but is too debt-burdened and risk-averse to spend it. If we refinance their mortgages and make the banks take the hit, the paper believes, then they would start buying plasma flat screens again thanks to the housing wealth effect. So, if the Times were right, then the savings rate would be much higher than now because its "underwater middle class" would be rebuilding its equity. It's not, which is bad because high consumer spending means people are depleting their savings to maintain their standard of living.

More likely, better-off Americans are the ones who have the wealth and income to spend (and lend), but they are choosing not to.

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...written by David S.,
October 01, 2011 10:06

Dean,

I am glad that you confirmed the clarification of your point regarding bubbles and consumption. I figured that is what you had intended to convey.

I am an avid reader of your blog, and a fan of your books. I am especially appreciative of your writings which point out how conservative arguments regarding economic issues fail to apply the fundamental economic concepts taught in basic economics courses.

I think that the issue involving consumption, aggregate demand and bubbles can be well-understood through this prism as well, and I would think that you might want to make the case at some point.

In summary: In the very first introductory economics lesson, economics is defined as the study of the allocation of limited resources to unlimited wants. At this nascent point, money is not even considered.

The point is nicely illustrated by the simple production possibilities curve, and the concept of the production possibilities "frontier." When a society operates inside the curve/frontier, there is a waste of resources, including human resources in the form of unemployment.

The "bubble" allowed our economy to operate on or near the frontier, maximizing our use of resources, and approaching full employment. Unfortunately, the misuse of credit, the imperfections of the financial markets and the short-run thinking of financial actors, to mention but a few problems, caused us to be on a point at or near the frontier which did not bode well for staying at or near the frontier in the long-run.

Thus, when the collapse came, our use of resources collapsed to a point inside the frontier. Why? The resources were still available. However, as Keynesian economics makes clear, it is the use of money as a store of value and as a safe liquid asset which becomes important at this point. The failure to spend money to sustain aggregate demand keeps us within the production possibility frontier. Heavy debt burdens, stagnant wages, unavailable credit, risk of unemployment, actual unemployment all combine to keep us in that position. Moreover, the demand for liquidity is so great that monetary policy at the zero bound becomes of little or no value (the liquidity trap analysis). Unless government spending (G) pulls us out (when C + I + X (net)cannot), we remain below the frontier in successive time periods indefinitely.

This is really basic stuff -- even the fresh-water guys were taught these basics, and these elementary concepts are beyond dispute. That is, if you deny the production possibility concept, and its necessary implications, you are simply no longer "doing economics" -- to paraphrase Paul Krugman, you are simply making things up without a model, just to support your own political ideology or to feather your own nest in some future Republican administration.

Anyway, Dean, for what it is worth, I hope you will expand on this idea.

Especially now that it is politically impossible for the government to invest in infrastructure projects, the ONLY option, as Keynes said, is to increase the propensity to consume.

That is what government spending should be focused on, but economists like Baker and Krugman oppose government incentives to increase consumer spending. They advocate that consumers repair their balance sheets by cutting spending and increasing savings.

Nothing could be more anti-Keynesian.

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yeah I'm late to the gamewritten by joe,
October 08, 2011 4:19

but no one has mentioned that the ratio dean speaks of is basically meaningless without knowing the numerator and denominator. Consumption as a percentage of disposable income could be rather high and yet still be "depressed" because people's disposable incomes are depressed. Lots of people took hits to their incomes just to keep their jobs and others like me haven't seen a raise in 3 years. Or a husband and wife may have lost one income and cut back their spending, but since they have less income they're spending a greater share of it.

That chart is meaningless without knowing what people's disposable incomes are. (he's probably covered that elsewhere, but this post in isolation is useless). He often points out that working hours are low, which should suggest lower wages, thus spending a greater share of income just to stay afloat.